Hi Era friends,
As a few of you know, I am a longtime licensed mortgage Loan Officer. Over the years (here and at the site that will not be named) I have had the pleasure of coaching some of you regarding the tangled web of credit and home financing. It is always extremely fulfilling to me to have those advice opportunities, especially for the folks here. When someone needs help, you are some of the best out there, so this is my little way of trying to contribute.
Point being, this community has done so much for so many, that I have long considered making a thread like this to try and give back a little. With it being the slow season in the industry, I finally decided to take some time to write something up. This is intended to simplify something that is often intimidating for people, and to provide you insider pro-tips related to mortgages. Put simply, these are the things I tell my friends and family.
This will be long, but I want to make this comprehensive. If you plan to obtain financing to buy a home, start with a thorough review of the details below and you will be far more educated and in a position to both negotiate and not be taken advantage of. For the sake of not making this OP too ridiculously long, I will focus almost exclusively on new first mortgages, mostly ignoring mortgage refinances. If there is demand, I can always do a write up on those as well.
I will break this in to three sections – Basics, Pro-Tips, and Miscellaneous. If you already understand the basics, I would skip to sections II and III. That's where the good stuff is.
I. The 7 Basics of Mortgages
III. Miscellaneous Pro-Tips
As a few of you know, I am a longtime licensed mortgage Loan Officer. Over the years (here and at the site that will not be named) I have had the pleasure of coaching some of you regarding the tangled web of credit and home financing. It is always extremely fulfilling to me to have those advice opportunities, especially for the folks here. When someone needs help, you are some of the best out there, so this is my little way of trying to contribute.
Point being, this community has done so much for so many, that I have long considered making a thread like this to try and give back a little. With it being the slow season in the industry, I finally decided to take some time to write something up. This is intended to simplify something that is often intimidating for people, and to provide you insider pro-tips related to mortgages. Put simply, these are the things I tell my friends and family.
This will be long, but I want to make this comprehensive. If you plan to obtain financing to buy a home, start with a thorough review of the details below and you will be far more educated and in a position to both negotiate and not be taken advantage of. For the sake of not making this OP too ridiculously long, I will focus almost exclusively on new first mortgages, mostly ignoring mortgage refinances. If there is demand, I can always do a write up on those as well.
I will break this in to three sections – Basics, Pro-Tips, and Miscellaneous. If you already understand the basics, I would skip to sections II and III. That's where the good stuff is.
I. The 7 Basics of Mortgages
- What is a mortgage?
A mortgage is a financial instrument utilized to obtain a loan to purchase a home. Put simply, houses (and condos, co-ops etc) cost more money than most people have laying around. So money is borrowed from a lender to pay for the home, and then paid back over a period of time to the lender. Most often, this pay-back period of time is 15 or 30 years, with a payment due each month on the 1st.
- How do I obtain a mortgage?
A mortgage is obtained by applying for financing through a bank or other lending institution. The application is usually a meeting/phone call between the applicant and a licensed Loan Officer. The application process involves providing all of your personal details (Name/Address/Employment History/DOB/SSN/Income/Assets), agreeing to a credit check, and providing details on your desired purchase. The initial application typically results in a decline, or a pre-approval. This step is typically done prior to house shopping, and most realtors expect you to be pre-approved before they show you a home.
- What determines if I am declined or pre-approved?
There are two major components to being approved for a mortgage: Credit score, and Debt to Income Ratio (or DTI). There are many other smaller factors, but if you are solid in these, you are typically solid in all. I will touch on the ins and outs of credit scores and DTI requirements in the Pro-Tips section.
- What mortgage products are available?
This is where things start to get complicated, and where having a TRUSTED loan officer is critical. There are many mortgage products, but allow me to simplify as much as possible. Essentially, there are two mortgage types that make up the vast majority of what people utilize. Fixed rate mortgages, and adjustable rate mortgages (commonly known as ARMs). A fixed rate mortgage has an interest rate fixed for the life of the loan, so the payment never changes. These are usually 15 or 30 year loans, with 30 year loans being the standard. An adjustable rate mortgage has periods of adjustment over time, but starts with a lower rate than a fixed rate. Adjustable Rate Mortgages are usually fixed for 3-10 years (depending on product), and then adjust annually, up or flat, depending on the market.
- Are there other costs involved beyond making a monthly payment?
Yes. These are called "Closing Costs," and vary depending on which institution you are working with. These can range from several hundred to several thousand dollars, all due when you close on the loan. Some lenders will offer you credits off of these fees, or on a mortgage refinance, allow you to finance the costs in to the loan total. This is absolutely something you should NEGOTIATE. You are also typically required to bring in money at loan closing as a deposit for your taxes and insurance. More obviously, you also typically have to have a down payment money, as in most scenarios, 100% financing is not available.
- How much money is needed for a down payment?
This can vary widely depending on the loan program, or if you qualify for special financing due to being a veteran or physician. The rule of thumb for many is to put down 20% of the home price, but this is NOT typically required. However, by putting down 20% you avoid having an extra monthly charge called Private Mortgage Insurance (or PMI) added to your monthly payment. This extra charge is usually .5% to 1% of your loan total. This exists to protect the lender against you defaulting on your loan. There are programs that exist that allow you to put as little as 3.5% down, and with some specialty products, little or nothing at all. This depends on your state and products available by the institution you are obtaining your mortgage through. But most often, 3.5% is the required minimum.
- How long does it take to obtain a mortgage, and what is involved?
After the initial application, you will then be required to submit paperwork to the lending institution to verify the data you have provided them. Most full loan approvals take around 30 days, which is the standard time written in to most real estate contracts. During that time period you will submit documents like paystubs and W2s to prove your income, and bank statements to provide your down payment is coming from a legitimate source. It is also typical that you will need to provide "Letters of Explanation" to explain items like recent credit inquiries, late payments, random addresses associated with you on your credit report, etc. All of these documents are reviewed by a mortgage underwriter, who may then ask for additional documents to better clarify certain scenarios. After all documentation is approved and no further questions exist, you are then typically "clear to close" on your loan.
- Where the hell do I start the process?
The easiest way for me to answer this is with a **disclaimer** opinion - NOT A BANK. Do not rely on a Wells Fargo, Bank of America, Citi, or even your local bank for your mortgage needs. Instead, call a local mortgage broker or direct lender. Google is your friend. Or ask around for recommendations. Why you may ask? Banks are big, slow and have tighter credit policy due to regulations. As a result, the process can be excruciatingly slow, with deadlines often missed. And because they are more heavily regulated than a direct lender, their underwriting guidelines are much tighter. Unless you fit a very specific mold, you can be declined more easily. They also offer fewer mortgage products and options. Ask any real estate agent. They cringe when their buyer is using a bank for their loan because they know the nightmare that often lies ahead. I spent almost a decade as a Loan Officer at a big bank, and now work for a Direct Lender. I speak from experience. I also cannot stress enough how important it is to find someone your trust. If they sound super "sales-ey", like they don't know mortgages as well as you do after reading this thread, and you cannot call them on their cell phone day or night, don't work with them. A good loan officer is a mortgage nerd, works for an institution that is small enough to have a wide variety of options for you, and makes themselves available as needed instead of just during office hours.
- Do I really need a real estate agent?
One is not usually required. but I always say YES. For one, they understand the ins and out of the home buying process. Need some repairs negotiated in? Need the seller to pay your closing costs? Let a realtor use their expertise to negotiate on your behalf. And secondly, you don't pay them a dime. Their costs are paid for by the seller of the home.
- What credit score is needed to buy a home, and how do I know where I stand?
This can get convoluted, and can depend on the lending institution, but for the most part you need to have a middle FICO score of 580 or above. And you really should know your middle FICO scorer before picking up the phone and calling a lender. So what is a middle FICO score? Well, there are three credit bureaus, and mortgage lenders use the middle score of the three to determine your qualifying score. Also important to know is that FICO is a formula used to calculate your score that very few other entities utilize outside of mortgage lenders. It can also be difficult to attain your true FICO score. In today's world, many people utilize an app like Credit Karma to determine their credit score. And while it can be a very useful tool, it provides you a score that is determined using a different formula than FICO. In my experience, Credit Karma is 30-40 points HIGHER than your true FICO, leaving many people to believe they are better qualified for a mortgage than they truly are. The better way to determine your FICO is through your credit card holder. Many now offer a free credit score every month. This score is almost always your FICO. If you do not have a card that offers this service, you can go to https://www.creditscorecard.com/registration.This is a service provided free of charge by Discover card, and does not require you to do business with them or pay a fee. I am sure they will use your info for marketing or even sell it, but I applaud their opening up this information to the general public with no obligation.
- What Debt to Income Ratio (DTI) is required to qualify and how is this figure calculated?
Put simply, DTI is your (pre-tax) gross monthly income measured against your monthly credit obligations. The equation is calculated by totaling up the monthly obligations on your credit report (minimum credit card payments, auto loans payment, student loan payments, etc), adding in your proposed mortgage payment, and dividing that number by your monthly income. Debt/Income. For example: $300 car payment + $100 minimum credit card payments + $1,000 proposed housing payment = $1,400, divided by gross monthly income of $4,000 = DTI of 35% (1,400/4,000). YOUR TOTAL BALANCES ARE IRRELEVANT, as are your other monthly bills (groceries, utilities, etc) If the payment is not on your credit report, it is irrelevant. Max allowable Debt to Income is usually in the 45% range, but some programs allow for as high as 55%+. This depends on the lending institution and programs available.
- Do I really need a 20% down payment ?
This was touched on in Section I. Question #6 above, but more often than not, no. Unless you are buying an investment property or taking out a mortgage over $421K, 20K down is rarely required, and is not always a good idea. You should however have a minimum down payment of 3.5%. So when is 20% down not a good idea? Well, let's say you only have 15% down. Sometimes, you can get a lower interest rate at 15% down instead of 20% down. It seems counter intuitive, but it's true. Yes, 20% down avoids the PMI discussed earlier, but a lower rate can mean a lesser payment, even WITH PMI involved. Additionally, will putting down 20% exhaust your reserves? Where will you get the money for furniture or renovations? It can be cheaper to finance that other 5% through your mortgage than it is to put that money on a credit card or store financing. This is where you need a Loan Officer that knows their stuff and can help you weigh all of your options.
- A 30 year fixed rate mortgage is always the way to go, right?
It is certainly the most popular mortgage product, but not always the best. What if you are only planning to live in the property for 3 years? Why would you take out a 30 year fixed at 4% interest, instead of a 5 year ARM at 3%? You will move before your rate begins to adjust after 5 years! Additionally, what if you plan to retire in 20 years? You don't want another 10 years of mortgage payments after retirement, do you? Believe it or not, you can actually take out a mortgage with almost any repayment period you desire. Typically, 10 years is minimum, but you can customize your repayment period. Want a 27 year loan instead of 30? How about a 12 year instead of 15? Again – talk to a trusted loan officer that can help you weigh your options. Don't blindly accept a 30 year fixed rate mortgage just because it's a lower monthly payment.
- Okay, so I'm ready to pull the trigger on getting a mortgage. How do I get the best deal?
This is the big one. First and foremost, know where you stand. If you want to do this yourself, obtain your credit score by utilizing the methods outlined in Section II. Question # 3 above. The higher the score, the better. But if your FICO is below 580, you probably have some negative reporting data you need to work on first. Get your score up a bit by paying off those medical collections, making your payments on time, etc. Next, have a good idea on your DTI (Section II. Question #4). You want to be below 45%, and if not, perhaps pay something off to lower your monthly obligations. Again, there are programs that allow for higher than 45% DTI, but this is a good rule of thumb. All of that said, sometimes it's a good idea to simply allow a trusted Loan Officer to pull your credit and analyze your income, and then provide you a TRUE picture. Once you know exactly where you stand, you can begin to negotiate. You only need this done by one lender to call around and ask for the best deal. No one HAS to pull your credit to give you a rate and cost estimate. You simply say, "I am calling for a rate and price quote. I can tell you my credit score, house price, down payment amount, and I know my DTI is X%." Comparison shop. Ask for lowest rate and lowest closing cost they can offer, and then pick the best option. Ultimately, if you do decide to go with someone other than who initially pulled your credit, the additional credit pull will not count against you if it is within 30 days of the original pull. The credit bureaus recognize that you are shopping rates.
III. Miscellaneous Pro-Tips
- Assets
In order to qualify for your mortgage, you will have to provide 2 months bank statements to show where your down payment is coming from. If there are large, non-payroll deposits showing on those statements, the mortgage underwriter will ask you to provide proof of source. Maybe this is relatively easy because the deposit is from stock you liquidated, but you will still have to show a paper trail proving that. What a pain. Or, maybe you had the money stuffed in your mattress because you don't trust banks and cannot prove it's source. This is a problem. Point being, do your best to "season" that down payment money for 2 months and turn in easy to read bank statements that will not require a lot of additional documentation.
- Income
Are you a W2 employee? Great. Your application is usually pretty straight forward. Self-Employed? Well, hopefully you are schedule C. If not, prepare for a LOT of explaining and paperwork. Even if you are schedule C, your qualifying income is what you report as NET PROFIT AFTER EXPENSES. That is great that your tax guy helps you make your 1 million dollar a year income look like 30K, but that 30K is now your qualifying income. Thems the rules.
My final piece of advice here is really re-iterating what I have said above many times – work with someone you trust, that is readily available to you, and that you can negotiate with. A product like Rocket Mortgage is ok if you have a cookie cutter credit/income scenario and want a non negotiated, cookie cutter mortgage - but I would steer clear. Look at knowing a good loan officer like knowing a good car mechanic. You want someone you trust to look under the hood, that you can have an actual conversation with, and be able to call them as needed if any problems arise.
Well Era, those are the basics and then some, without getting TOO FAR in to the weeds or down the rabbit hole. This already took almost 3 hours to type! I really hope that some of you can find this information helpful.
That said, please reply or message me with any questions you might have. I will do my best to check in here regularly to answer them.
